It’s well known that the credit crunch abroad and the stock market crash have led to companies not being able to borrow overseas or tap the market for equity funds. The upshot is that all the demand for funds that used to be met by these non-bank sources is now being diverted to domestic banks. But just how dependent have Indian companies become on non-bank sources of funding?

In 2007-08, according to Reserve Bank of India data, bank credit to industry was Rs1,74,566 crore while the flow from non-banks to companies, which includes capital issues, ADR/GDR issues and external commercial borrowings (including short-term credit) and commercial paper, was Rs2,39,626 crore. So, the sources of funds to industry from non-banks during 2007-08 was 137% of the credit extended by banks to industry. In 2006-07 also, sources of funds from non-bank sources were larger than bank credit to industry.

In other words, in the last couple of years, companies have become more dependent on the capital markets and on borrowing from abroad than on local banks to meet their funding needs. That will make it very difficult for banks to meet all the funding needs of companies.

What’s more, the total funds provided to industry in the last few years have been growing by leaps and bounds. In 2005-06, for instance, total funds to industry (non-bank sources plus bank credit) rose by 71.6%. In 2006-07, this growth was 54.7%, decelerating to 39.9% in 2007-08. It was this massive growth in the availability of funding that led to a huge expansion of economic activity in the country. It funded the capex plans of industry and enabled firms to increase hiring. It also added to income and boosted savings. It increased the treasury income of companies and boosted profits. And all this excess is now being unwound.

True, the need for funds by companies will be much lower in the months ahead, what with many of them cutting back production substantially and putting projects on hold. But at the same time, their internal funding sources, i.e., their cash flows, too, will be much lower because of lower profits.

Companies that had raised money earlier will soon find that it is running out. And funds will also be needed by banks trying to replenish capital.

All this makes it very likely that the cash crunch is here to stay, until borrowing costs come down substantially abroad.